So you’ve found a house you’re really interested in, and now you have to find a way to come up with the down payment. Maybe it’s beginning to seem pretty hopeless. But if you’ve been steadily employed for some time, you do have options – and those reside in your 401k. Depending on your situation and what will work better, you can withdraw from it or borrow from it. So let’s see how to use your 401k to buy a house in Los Angeles.
Withdrawing From Your 401k
The first way to use your 401k to buy a house in Los Angeles is to withdraw from it. When you pull money out of a 401k, there isn’t any specific penalty exemption for home purchases, so the money you withdraw will be classified as a “hardship exemption.” And this means you will have to pay a penalty of 10% on the amount you withdraw, as well as having to pay income tax on it.
A good strategy, in this case, is to, if possible, roll the amount wish to withdraw over to an IRA to avoid paying the penalty. You should be aware, though, to do this, it would have to be an old 401k with a former employer. You can’t roll over a 401k with an employer you are currently working for.
Even if you can’t do the roll-over, your mortgage-interest tax deduction may offset the “income” you have to report with a 401k withdrawal. The mortgage-interest deduction can effectively cancel out the tax owed on the withdrawal. You will, however, still have to pay the 10% penalty.
Borrowing From Your 401k
Most financial experts recommend borrowing as a better way to use your 401k to buy a house in Los Angeles. You can borrow up to $50,000 or half the value of your account, whichever is less. If you can handle the payments, borrowing is usually a less-costly option than a straight-up withdrawal. Although you’ll pay interest, you won’t have to pay a penalty or any taxes.
There are, however, a few things you need to be aware of:
- Even though it’s your money in the 401k, this is indeed a loan with monthly payments. So borrowing from your 401k may affect your ability to get a mortgage.
- A 401k loan generally carries an interest rate roughly two points above the prime rate – although that interest does go back into your 401k account.
- Generally, these loan arrangements are only for five years. So if you borrow a large amount, the monthly payments could be pretty hefty.
- And if you leave the company, you may have to back the outstanding balance within a 60-90-day period or take that balance as a hardship withdrawal.
Still, borrowing as a way to use your 401k to buy a house in Los Angeles, especially if it’s just to come up with a fairly small down payment, can be a good option. If, for example, you were able to get an FHA loan and needed only a small down payment, then this would be the way to go. A larger loan, as we mentioned, could hurt your ability to get financing, so be sure to run the number and see if a withdrawal might be the better course.
Owning your own home can be a reality because you can use your 401k to buy a house in Los Angeles. You just need to figure out which option – withdrawing or borrowing – is best for you and be aware of the consequences in each case. This is also a situation where a real estate professional can be a valuable resource. And we are prepared and eager to help.